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Global debt levels raise red flags

Champagne corks popped towards the end of 2019 as US equity markets notched up another sterling year, with the S&P 500 gaining 28%.

The MSCI World Index ended the year 24% higher, with local investors also benefitting from the weaker rand.

In contrast, the JSE All Share Index rose only 10% for the year.

The US Federal Reserve was seemingly vindicated with its stance to halt further interest rate cuts, supported by a strong US economy.

Jobs data in the form of nonfarm payrolls surprised to the upside in November and, together with unemployment at a record 3.5%, reflected a vibrant US economy not in need of further upliftment through lower rates – as the Fed indicated earlier.

The surge in equity markets coincided with renewed merger and acquisition activity, reaching its highest level in two decades.

But things look somewhat different this time.

The high equity valuations provided the opportunity for companies to finance mergers with share issues, and not external bank debt.

This is a much more prudent approach, which could mitigate any fallout in the event of a financial crisis or market pullback.

However, before popping more corks, it would be circumspect to be reminded of what Fed chair Jerome Powell said only a few months ago.

Appearing somewhat perturbed, Powell noted that US debt was now growing faster than GDP, “which was clearly unsustainable”.

Indeed. Global debt levels have risen to a staggering $250tr, the highest peacetime level in human history.

In the US, total public debt of $22tr has now surpassed GDP of $21.3tr.

In Japan, the debt-to-GDP ratio stands at 243%.This raises the question: Have countries reached a new economic level where they can live indefinitely with high debt levels by tweaking rates to lows and stimulate the economy by continued asset-buying exercises, no matter what?

Or is a crash imminent?At the start of 2020 the US economy entered its 12th year of continued expansion, without any major financial crisis. This unheard of development has certainly bolstered sentiment that a new era has arrived.

Powell himself said that the record low levels of unemployment without any concomitant rise in inflation has surprised the Fed. However, in a rational discourse, it seems unlikely that the explosion in world debt can continue in a linear fashion forever.

That would mean that debt can be added on to existing levels indefinitely, which flies against reason. Total global debt in 2008, before the crisis, was around $180tr.

A decade later, debt has grown by a further $70tr, and if present trends continue, would entail global debt surpassing $300tr in a few years.

At present, the growing debt juggernaut seems unstoppable, and among the big economies, it is Germany that is feeling the heat the most.

On face value, the German economy is run very efficiently, with a budget surplus, a positive current account and an actual reduction in its debt-to-GDP ratio of 65% in 2008 to 62% in 2018.

In the eurozone as a whole, comparable levels climbed to 85% from 70% and in the US from 70% to 101%. But why is Germany then facing major headwinds now?

It barely escaped a recession in the third quarter of 2019, its motor industry is facing major layoffs and exports are plummeting. Contracting global trade is certainly a factor.

But maybe saving, and following prudent economic policies, are not what they are cut out to be in the modern era of debt accumulation. Because the German stance has come at a price.

Infrastructure has deteriorated markedly. Innovation has suffered, while the country could be falling behind on global digital developments through the lack of investment spending.

Those countries running stimulatory policies have been able to boost economic growth much better. At positive levels. Although there seems to be a level at which much higher growth is impacted when debt growth is excessive.

However, even Japan has combined its high debt level with economic growth, albeit marginal, by embarking on stimulatory steps while bond rates are negative.

At present, nobody is really suggesting that global debt needs to be paid back. Apart from habitual bond settlements. The conventional view, including one held by the Fed, is that higher economic growth will impact debt-to-GDP measurement positively.

A little higher inflation might also come to the rescue. Debt levels will contract in a natural way without embarking on any drastic measures.

Global household debt has in fact dropped over the past few years. Debt from financial corporations has also decreased. It is only government debt that is in an upward trajectory. From 60% to 100% of global GDP.Maybe everyone is living in a fool’s paradise.

But at this moment there is little alternative but to continue with a dovish stance from central banks, to support asset growth in equity markets. And for debt levels to accumulate further, to save the world from Armageddon.